While the answer is quite obvious, the question largely remains whether it can be addressed. So, what was the obvious part! Just take a look at the weights of different stocks in the Nifty and the Sensex. In the top 10% of the weights - ONGC, Reliance, Bharti and TCS dominate the Nifty and Infosys, Reliance and ICICI Bank dominate the Sensex. Barring Reliance, we saw some phenominal returns in the rest of the stocks. Add the next 10%, and with just 6 stocks in the Sensex and 10 Stocks in the Nifty, you have covered 50% of the index. You do not have to invest in the rest 80% of the portfolio!! to replicate half the index.
Next is to look at the performance of these stocks. I have taken a period from 24 July to December 8, 2006. This is when we started seeing the amazing rally in the Index. The stocks that has contributed has been none other that the ones that represent just 20% of the index.The rest 80% of the companies just gave a return of approximately 16%. So the question arises as to whether having such a skewed sensex or nifty actually makes sense in the first place.If one has to compare his portfolio, this is surely not the best benchmark. I just have to add these stocks in my portfolio and make merry and if I do not then there it is end of the road for any fund manager. It is for this reason we see a similar portfolio. No fund manager wants to be left out from this race of out-performing the index.
I tried to build another Index - a Price Based Index as followed in NYSE. Simple to calculate but has certain deficiencies. The stock with the highest price will tend to play heavily on the movement of the index. However, it is good our index does not follow that method as the returns would have exceeded 40% (under certain assumptions). Well, the weighted price does look a lot better that this method.However, if one follows a value line price index of an equal amount of investment in every stock in the portfolio, the return falls substantially to 23%. This looks a lot better than 35% that we saw earlier.
But is this what we need to expect from an index? I firmly believe that this should not be so. With more and more money coming into the country, the fight will always be with this set of stocks which is going to drive the price even further leaving fundamentals out of the window. What I expect of an index would be to represent the overall movement of most stocks in the market. What do we do then? I believe the focus should start moving from BSE 50 or Nifty Fifty to a probably broader index. A BSE 100 or BSE 200 or Nifty Junior should be an ideal one to start with. As we see more liquidity and transparency in the other set of companies, we can start having a BSE 500 or Nifty 500 as an ideal benchmark. Surprisingly in fall that has happened over the past few days, my portfolio was rather safe than the way the index fell. Now, that is not smart investing but just that my portfolio has stocks that do not represent the top half of the index. Hence, I tend to perform when the index corrects!! Now that is what is called contrarion investing.
